Behavioural Finance and Brexit

The EU in-out referendum provided a satisfying demonstration of many behavioural finance principles. The way we think about big political issues mirrors the approach we take to our finances. Most us - remainers and Brexiteers alike - make both political and personal financial choices on emotional rather than rational grounds.

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The EU in-out referendum provided a satisfying
demonstration of many behavioural finance principles. The way we think about
big political issues mirrors the approach we take to our finances. Most us -
remainers and Brexiteers alike - make both political and personal financial
choices on emotional rather than rational grounds.

The referendum debate was above all a victory
for short-cuts in thinking rather than the rational examination of the facts
and principles - as behavioural finance would predict.

Heuristics (mental shortcuts for decision
making), ruled the national argument and probably decided the outcome. Taking
back sovereignty, and taking back control of our borders were the powerful
catch-phrases that Brexit supporters hammered out day after day. We tend to
make decisions quickly and without excessive thought; and these behaviours are
crucial to an understanding of behavioural finance.

Of course those of us who got involved in
arguments could generally construct the very convincing arguments that
supported our case. But I suspect that very few of us actually made the
original decision to choose In or Out on the basis of the arguments we produced
for ourselves. For the most part we decided where we stood on the issue and
then marshalled the arguments to support our position, exemplifying beautifully
one of behavioural finance's most interesting insights - confirmation bias.

Anybody who got into an argument about Brexit
will recognise confirmation bias - in their opponents, if not in themselves. I
took part in arguments in many pubs, trains, offices and on the street, as well
as in sundry newspaper forums. Each side selected the arguments that suited
their case and ignored or ridiculed those of the other side.

Over-confidence was evident throughout the
campaign. Prof Kahneman - principal begetter of behavioural finance -
identified this attitude as the most robust finding of behavioural finance. The
cheery optimism of most Brexiteers that the fifth biggest economy in the world
would sweep all before it in negotiations with the rest of the EU was a
remarkable example of over-confidence. And it could be argued that the
remainers' rosy view of the future of the EU also betrayed a significant degree
of over-confidence.

But it is at least arguable that mistaken
lessons from behavioural finance also led to some of Osborne's and Cameron's
most crucial mistakes. Nudge tactics are at the heart of a lot of government
policy, and the Treasury especially has taken them on board including within
the FAMR recommendations.

The Remainers put fear at the heart of their
campaign, but as commentators pointed out, the threats didn't get through to
most of the voters. Even some of the remainers became sceptical about some of
the claims.

So what went wrong? Why did so many Brexit
voters ignore the experts and the great and good? After all, prospect theory
tells us that people hate losses about twice as much as they like gains. On
that basis they should have been worried. The potential loss to future income
and livelihoods should theoretically outweigh the possible benefits of leaving
the EU and sailing the open seas of the world economy.

There are lots of answers to this - a
straightforward protest vote against the political and economic elite is just
one. But there are behavioural finance issues too. First and perhaps foremost
was the immigration worry. Immigrants are far more salient - obviously visible
- than vague economic warnings about the future.

Then there is the question of the warnings about
the immediate future and probably the longer term future. We don't value our
future lives as much as we value our current selves. Overcrowding in schools
and hospital is here and now. Experts can predict all they like about the
future, but they can be wrong. We hyperbolically discount both good and bad
things in the future, according to the behaviour economists. As Martin Talks
said at the Platforum D2C and Digital Conference last week: our future selves
are strangers, and we don't worry too much about strangers.

The chancellor also undermined his credibility
by using some very exact numbers about the Treasury's estimates of how much
people would be worse off in 2030. The hope was that voters would anchor on the
specific number of the average family being £4,300 a year worse off in 2030
post-Brexit. When many people scorned the improbably precise figure for such a
distant prospect, Osborne backed off somewhat. The £4,300 a year did not became
a salient number on which the voter would anchor, and the credibility of the campaign
and the warning were fatally undermined.

In contrast, the Brexit side focused on the £350
million a week they alleged went every week from UK to the EU. Despite
accusations of inexactitude - lying - they persisted with the claim and the
number stuck.

Not only were they successful in getting the
nation to anchor on a number, they proved just how bad most of us are at
assessing the size and importance of numbers. Even if the government had been
sending this amount to the EU every week, it would have represented a tiny
proportion of GDP or government spending.

In fact, polls confirmed what behavioural
finance has showed many times: we are mostly very bad at assessing numbers. Many
voters hugely overestimate such metrics as the number of immigrants in the UK from
the EU and elsewhere or the number of Muslims. There is nothing special about
the level of ignorance in UK. According to Ipsos MORI we are less ignorant than
the inhabitants of most nations - well above people in France and US for
example.

Group think is another phenomenon identified by
the behavioural finance experts. We ask our colleagues and friends what they
think, and often take our cue from them about financial decisions - from how
much we end up saving in pensions to what funds we decide. Salesmen all over
the world know the power of the phrase: "People like you buy
this........" There was plenty of group think during the run-up to the
referendum on both sides. And one group turned out to be bigger than the other.